Windfall Management Exercise #illumedati


Hey everyone, it’s Finance Fridays… but I forgot to write this post on Friday — so here it is — on Saturday. Sorry about that. Anyways, let’s do a “Windfall Management Exercise”.

Stock Photo from: Pexels

Windfall Management Exercise?

Yea.

I’ve talked about windfalls before in some previous posts. A windfall is defined as:

1: something (such as a tree or fruit) blown down by the wind
2: an unexpected, unearned, or sudden gain or advantage

from Merriam Webster

In this context, we are talking about a financial windfall, meaning suddenly receiving an unexpected amount of cash or some other asset (like property)


Like an inheritance?

Well. Kind of.

An inheritance is usually somewhat expected when it traditionally comes from your parents. In this particular case, we’re talking about something unexpected. Something like, you win the lottery, a rich uncle passes away suddenly leaving you money, or your long shot stock bet paid off. Something unexpected.

In general, this is not something you can prepare for because it so unexpected. However, I think it’s kind of an interesting (and fun) financial exercise to do. Just to make things easy, let’s just say you suddenly were entitled to $1 million. You can dream up whatever scenario you like from above:

  • You win the lottery.
  • Your rich uncle passes suddenly and leaves you money
  • Your stock bet on ACME Co when it was IPO and then forgot about, is now 1000x.

The long and short of it is that you suddenly now have $1 million. Also, just to make it easy, let’s just make all the money post-tax, meaning the taxes are already paid. The $1 million is just sitting in your bank account with the taxes all paid waiting for you to do something with it.


What would you do with it?

There is a lot of good discussion on how to handle a sudden windfall. A great place to start is here:

Managing a windfall — Bogleheads Wiki

However, don’t go there yet. This is an exercise, and kind of a quiz/test. Without any outside help, you should think about your own list of assets/liabilities and your plans for retirement and think about what you would do to best manage this $1 million windfall.

A lot of this is based on who you are, your retirement goals, your liabilities, your responsibilities, and your own risk tolerance.

There is no right answer for everyone. There is only the best possible answer for you.

So take some time and write down your “plan”. When you’re done, come back and read the rest of this post.


Wait.. what about you? How would manage it?

You’re right. It wouldn’t be much fun unless I did the exercise myself right?

Ok, so unfortunately, my answer is probably pretty boring. I’m pretty conservative in general and I’ve talked about My Number before. $1 million (even post-tax) would not be enough to significantly alter my future plans. Most likely I would pay off my loans, pay down some of the mortgage of my house, and bulk up the 529s for the kids. Then whatever is left over I would just throw into a taxable account with a three fund portfolio.

In terms of retirement planning, depending on how the taxable account does over the next 10 years or so, I could consider retiring a little earlier than planned maybe. However, having a $1 million windfall probably would allow my wife the flexibility to drop down to part-time work if she wanted.

Don’t get me wrong… $1 million (especially post-tax) is A LOT of money. However, at this stage in my life it isn’t enough to drastically change our retirement plans. Perhaps the age at which we can retire might be a little bit earlier — but that’s about it.


Wait… that’s it?

Well… yea.

There are many other more aggressive things (financially) you can do with a $1 million windfall. I’m sure some people would prefer to invest in real estate or help finance a business endeavor. However, both of those things are too risky for me. While it’s possible that they could return more than the 3-5% interest that I have to pay on student loans and mortgage, they are not a “sure thing”. Also, they require some degree of time/effort in order to do. Passive income doesn’t start passively.

$1 million, even post-tax, while being a lot of money, is simply not enough to significantly alter my retirement plans.


Ok, I’ve done the exercise… now what?

Well, now it’s time to look at some good rules of thumb when managing a windfall (all from Boglehead wiki, but with my commentary), and see how you did:

Take your time

Finance authorities are in agreement that avoiding immediate impulse decisions is key to prudent management of the windfall situation. Among the recommendations for this period are the following:

  • Set aside six months to one year’s income requirements in a transaction account such as your checking account. Place the remaining windfall assets in separate accounts holding secure low-risk savings vehicles, such as FDIC guaranteed bank accounts and CDs, money market funds, and treasury bills.
  • Use this period of time to begin resolving emotional, family, and social issues.
  • Begin to think about long term goals and how they might be attained. Whether or not you are inclined to “do-it-yourself”, this period is a good time to read some recommended books on personal investing. This can help you know what to look for in an adviser or advisers.
  • Begin thinking about creating a new financial plan that incorporates the windfall.

Commentary:

I agree with the idea of, “fix everything else first” and giving yourself some time to think.

The worst possible course of action would be to jump headfirst into something without a plan in place and significant research performed. There are many, many stories of lottery winners who have squandered absurd amounts of money in a relatively short amount of time:

20 Lottery Winners Who Lost It All – MSN.com

All of this is just another reminder that money isn’t happiness. Only happiness is happiness.

Money is just a tool like a hammer or a shovel. Like any tool, it can be used for good or evil, to create or to destroy.

Determine your tax situation

A windfall often involves tax obligations. Estimated taxes may need to be filed. Complex tax issues may surround distributions from retirement plans, inheritances, and lottery winnings, as well as the exercise of stock options. If professional tax assistance is warranted, enlisting the help of a Certified Public Accountant (CPA) who does not sell investment products may be a prudent step

A CPA may have a Personal Finance Specialist (PFS) designation. A good CPA can do the following:

  • Calculate any taxes due on the windfall and potentially minimize the taxes owed;
  • Recommend any additional types of insurance you may need, or what current types of insurance you hold may no longer be needed;
  • Determine whether you need to enlist an estate planning attorney;
  • Calculate whether it is better to receive a lump sum or annuity stream of payments from a settlement, lottery winning, or retirement package.

Commentary:

Death and Taxes. The only two constants in the world.

In this particular exercise, we made it easier by assuming that the $1 million was all post-tax money. However, in the event of a real windfall, you need the help of a very good CPA to make sure you are all good on your taxes. Then you will need to consider estate planning. The math behind the lump-sum payment versus annuity payments may also be something you will need to consider (and debate).

The final part is:

Formulate a Plan

Plan = financial plan

This is a step-wise approach which is kind of too long for just one post, however, from that wiki, these are the steps (in general):

  • Establish goals
  • Evaluate your financial status
  • Investing your capital
  • Investment Policy Statement
  • Execute needed estate planning documents
  • Monitor the plan & make necessary adjustments

Even if you’re well-versed in finance, it would probably be a good idea to find a good fee-only financial adviser to help you align your goals. Things may get little more difficult to be objective when its a lot of money and potentially life-changing. Don’t lose sight of the forest for the trees.


Windfalls may or may not be life-changing

Like I said, for me, $1 million isn’t enough to drastically alter my retirement plan or overall financial plan because of my list of liabilities/responsibilities. This would be very different if I had fewer (or not) liabilities or fewer (or no) responsibilities. It also depends on what you want from life. Your mileage may vary. (YMMV)

For some, there is a heavy priority on retiring as soon as possible. As for me, I’m not in that huge of a rush to retire. I don’t want have to work into my 70s, but I don’t think I’ll have much difficulty working into my 60s as it stands now. That said, I would like to have the option to consider retirement in my mid or late 50s. Of course, all of this is subject to change.


TL;DR

$1 million (post-tax) windfall, what do you do? Go!

For me, not much would change except it would put many of my liabilities behind me and maybe allow me to retire slightly earlier.

Your mileage may vary. (YMMV)

Money isn’t happiness. Only happiness is happiness.

Money is just a tool like a hammer or a shovel. Like any tool, it can be used for good or evil, to create or to destroy.

Finance Fridays Sensei

-Sensei

Agree? Disagree? Questions, Comments and Suggestions are welcome.

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